Formal and Informal Sector Credit Explained

Formal Sector Credit in India

  • People obtain loans from various sources.
  • The various types of loans can be conveniently grouped as formal sector loans and informal sector loans
  • Formal loans include the money borrowed from banks and cooperatives.
  • The informal lenders include moneylenders, traders, employers, relatives and friends, etc
  • The Reserve Bank of India supervises the functioning of formal sources of loans.

How Reserve Bank of India supervises the formal credit sector

  • The Reserve Bank of India supervises the functions of banks in various ways:
    • RBI holds a part of the cash reserve of the commercial banks.
    • RBI mainly ensures that the banks maintain a minimum cash balance out of the deposits they receive.
    • The commercial banks have to submit information to RBI on how much they are lending, to whom, and at what interest rate, etc.

Need of Expanding the formal credit sector in India

  • We need to expand formal sources of credit in India:
    • To reduce dependence on informal sources of credit because the latter charge high interest rates and do not benefit the borrower much.
    • The Reserve Bank of India supervises the functioning of formal sources of loans.
    • In contrast, there is no organisation which supervises the functioning of informal source of loans or the credit activities of lenders in the informal sector.
    • After taking loans from informal lenders sometimes, leads the borrowers to debt trap because of the high interest rates
    • In India, the formal sector sources of credit are still only about half of the total credit needs of the rural people.
    • Thus, it is necessary to the formal sources of credit expand their lending especially in rural areas, so that the dependency on the formal sources of credit are increased, which would benefit the development of the country on a wider scale.

 

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